Spoilt for choice on mortgages

Ten years ago, choosing a mortgage was simple. You took out a loan with a variable rate that went up and down in line with interest rates and the only question was whether to go for a repayment or an endowment.

Now, hardly a week passes without at least one lender announcing a range of fixed-rate, discount, capped or tracker-rate loans. Lenders vie to find ingenious new ways of dulling the pain of paying off a long-term loan. How about an offset loan, where your savings or current account are set against your mortgage so you reduce your mortgage debt and earn a better rate on your savings at the same time? How about a loan where you can overpay or underpay? Do you want to pay back your loan early? Or would you like your payments fixed for the term of your loan?

These options are there for the taking. Lenders are desperate for business and are responding to demands from borrowers for innovative ways of lowering costs having maximum flexibility.

The notion of customer loyalty has all but disappeared as borrowers switch lenders to cut their mortgage outgoings. Remortgages now account for around half of all mortgage business, according to the Council of Mortgage Lenders. Many lenders will cover the cost of valuation, legal fees and arrangement fees, totalling £1,000 on average, to tempt borrowers.

So there's no excuse for paying too much for your loan. What should you be keeping an eye on in the mortgage market to get the best deal?

Fixed rates

Lenders are falling over themselves to compete on two-, three- and five-year fixed rates and buyers are snapping them up. "Fixed rates are now being marketed at the same rate as discounted loans so there is increased take-up," says David Hollingworth of L& C Mortgages. You should not have to pay more than four per cent for a five-year fixed rate or more than 3.5 per cent for a two-year fix. There should be no penalties for changing to a better deal or moving lender after the end of the term.

Discounts, trackers and caps

If you want to take advantage of further falls in rates, check out discounted variable rates or trackers, which track base-rate movements. For protection against rate rises, you can take out a cap that guarantees your repayments will not rise above a certain level.

"A tracker with a cap is ideal because you can ride the market while limiting exposure," says Simon Harris of Savills Private Finance. The downside is that protection comes at a price. Portman Building Society has a three-year discount, putting its variable rate currently at 3.79 per cent, capped at 4.29 per cent. A three-year discount with no cap from Leeds & Holbeck Building Society currently stands at 3.65 per cent.

Long-term fixes

With plenty of choice of short-term fixes and discounts, it is not surprising that few borrowers are grabbed by the idea of fixing their rates with one lender for the next 25 years. Chancellor Gordon Brown wants to encourage home-owners to take out long-term (up to 25 years) fixed rates, arguing that it would stabilise the housing market and help align UK interest rates with those of other countries in Europe.

Only a handful of lenders offer 25-year rates. The Cheshire Building Society has the best deal, with a rate of 5.14 per cent over 25 years.

During that time, you can repay up to £5,000 a year of your outstanding debt and come out of the deal without penalty after six years. But this is not attractive enough, says Ray Boulger of Charcol. Borrowers have got used to playing the market and switching to get a cheaper rate, and they do not want to be tied if their circumstances change. Long-term fixes are worth considering only if they become cheaper and more flexible.

"Most people look at mortgages as a short-term deal. You can get a five-year fix under four per cent. If the Cheshire was offering four per cent, you'd be mad not to take it."

Flexible mortgages

It used to be rare to have a mortgage that let you overpay without penalty to reduce your outstanding debt, take payment holidays if you hit a tricky financial patch or borrow money back from your mortgage as a lump sum. Such flexibility was expensive, with high variable-rate repayments. But now flexible mortgages are mainstream, available at competitive fixed rates.

According to Boulger, 75 per cent of loans are flexible, including ranges from giants such as the Halifax, Woolwich and Nationwide.

Offset loans

The ultimate in flexibility is the offset mortgage, where you set your current account or savings against your mortgage. Rates are falling on offset loans as more lenders come into the market, keen to attract borrowers who may be more likely to stay loyal if their savings and loan are with the same lender.

Rates on offset loans are still between 0.75 per cent and one per cent higher than comparable non-offsets, and most are variable rather than fixed, but watch this space.

"The offset is the mortgage of the future," says Charcol's Ray Boulger. You pay interest only on your net outstanding debt. If you have savings of £10,000 and a mortgage of £100,000, you pay interest on only £90,000.

At the same time, you are effectively earning interest on your savings at a mortgage rate, rather than a lower, high-street savings-account rate.